EURUSD has been following yield differentials higher

The big recent upside momentum in EURUSD has caught me by surprise. The pair is currently sandwiched between major resistance at 1.1278 (the July 2023 high) and support at 1.1140 (the December 2023 high).

Now if we look at 2-year and 10-year yield differentials, we can see that the pair has basically just been following them higher as any objective analyst would expect them to. However, it’s what these differentials are based on that surprises me.

Money markets are currently pricing in more than 60 basis points of cuts for the Fed compared to the ECB by this time next year. But comparing these two economies with each other that seems odd. I’m of the opinion that markets are too pessimistic on the Fed and too optimistic on the ECB in terms of rate pricing.

But when momentum is this strong you usually need a catalyst to take the other side. And with money markets so focused on labour data it means we’ll probably have to wait for that before we get more clarity on where differentials head next.

This article was written by Arno V Venter at www.forexlive.com.